What is the Means Test?

In order to file a chapter 7 bankruptcy, a person must “pass” the means test.  If a person does not “pass” the means test, it may mean that the person will need to file a Chapter 13 bankruptcy.  We discuss the means test below and how it works in either a Chapter 7 or a Chapter 13 bankruptcy.

First Part of the Means Test – Gross Income

Let’s meet Oliver, our hypothetical client.  Oliver has consumer debt (i.e. not business debt) and wants to know if he can file a Chapter 7 bankruptcy.  A basic first test of whether Oliver can file for bankruptcy relief is to compare his annualized income to the median household income for household the same size in New Mexico as Oliver’s household.  In other words, if Oliver has a household of one (he only supports himself) and he makes less than $56,766.00 per year, then, assuming there are no other factors at issue, Oliver should be able to file a New Mexico Chapter 7 bankruptcy.

The household income is determined by median household income in the State of New Mexico.  As the household size increases, the median household income increases.  You can follow this link to determine the median household income for your household size and state:  https://www.justice.gov/ust/means-testing.  The median income also tends to increase based on cost of living and other factors.

To determine the annualized gross income for the first part of the means test, Oliver must provide information regarding his income for the 6 months prior to filing for bankruptcy relief.  For most people, this information is found in paystubs for wages.  Income also includes 1099 income (such as Uber or DoorDash income), self-employment income, rental property income, unemployment compensation, child support and alimony, and other governmental benefits.  Income does not include social security benefits, nor does it include veteran’s disability compensation.

Second Part of the Means Test – Disposable Income

Let’s say that Oliver, as a household of one, makes slightly more than the median household income of one for the State of New Mexico.  He will need to complete the second part of the means test to determine if he can file a Chapter 7 bankruptcy.  The second part of the means test allows a person to deduct certain living expenses and debt payments to determine whether there is sufficient income left over to pay back some debts.  The monthly disposable income is then multiplied by a factor of 60 (the length of a Chapter 13 plan) and depending on the amount of the disposable income, a presumption of abuse may arise.

“Disposable income” has a specific meaning under the Bankruptcy code.  We tend think of disposable income as income that could be used to buy a fancy car, go out to eat, or travel on nice vacations.  However, under the Bankruptcy code, disposable income is the amount of money left over after subtracting necessary expenses.  If your disposable income is insufficient to pay back at least 25% of your unsecured debts, then you can file a Chapter 7 bankruptcy in New Mexico.

If Oliver’s monthly disposable income over five years is $9,075 or less, then the presumption of the abuse does not arise and Oliver may proceed with filing a Chapter 7.  If his monthly disposable income over 60 months exceeds $15,150, then it is presumed that Oliver is abusing the bankruptcy process and should be required to file a Chapter 13 to pay back some of his debts.   These numbers are expected to change in on April 1, 2025 and every 3 years after that.  If Oliver’s income falls in between those two numbers, then Oliver must determine whether his disposable income over 60 months is enough to pay back 25% of his unsecured debts.

To determine whether there is sufficient disposable income, Oliver is able to deduct certain expenses from his gross income.  Some expenses, like housing, utilities, and food costs are limited to IRS standards for the household size in the State of New Mexico.  Oliver is also able to deduct his taxes, life insurance costs and health insurance costs.  If he is required to contribute to a retirement plan, such as a pension plan, that expense can be deducted from his gross income.  However, contributions to 401K plans or other similar plans, cannot be deducted from the gross income.  Repayment of retirement loans also cannot be deducted from the gross income.

Secured debt payments and tax payments can also be deducted from the gross income to determine whether there is sufficient disposable income to pay back creditors.  In other words, if Oliver has a mortgage payment or a car payment, those payments can be deducted from his gross income and can significantly reduce the amount of disposable income available to pay back unsecured creditors.

Chapter 13 and the Means Test

If Oliver is unable to overcome the presumption of abuse for filing a Chapter 7, he may have to file a New Mexico Chapter 13 bankruptcy.  A Chapter 13 bankruptcy uses a slightly different means test to determine disposable income.  Almost all of the deductions in a Chapter 13 means test are identical to the deductions in a Chapter 7 bankruptcy.  However, Oliver can deduct the contributions to 401k and other voluntary retirement plans from his gross income.  In addition, he can deduct any 401k or other retirement loans from his gross income.  After all of the deductions are taken, Oliver will then know his projected disposable income over the five years.  This projected disposable income states how much must be paid to general unsecured creditors over the Chapter 13 plan.

Even though Chapter 13 may not give the quick debt relief that a Chapter 7 bankruptcy provides, a Chapter 13 still provides a discharge of any unpaid unsecured debts at the end of the plan.  For example, Oliver may have $60,000 in credit card debt, medical debt or other general unsecured debt.  It is possible that he may only have to pay back $15,000 of that debt and the remaining debt is discharged.  In addition, there may be situations in which Oliver qualifies to file a Chapter 7 bankruptcy, but a Chapter 13 bankruptcy is a better tool for the situation.  For example, if most of Oliver’s unsecured debt is tax debt, then he would want to file a Chapter 13 bankruptcy.  If Oliver is behind on his mortgage payments or his car payments, he would want to consider a Chapter 13 to catch up on those payments and keep his house and his car.

There are many factors that can determine whether a person can file for a Chapter 7 bankruptcy and if they can file a Chapter 7, whether they should file for a Chapter 7 bankruptcy.  It is important that you consult with an experienced New Mexico bankruptcy lawyer to determine which is the right tool for you.